Weekly Market Commentary By H.E.R.O. (25 to 29 Oct 2021)

October lived up to its reputation as one of the most volatile months for markets, from a global bond bloodbath intensifying in the last week to a spike in energy costs. To stock bears’ chagrin, though, the tumult did nothing to halt the relentless rally in U.S. equities. During the week, MSCI ACWI All World index +0.4%, S&P 500 +1.3%, NASDAQ +2.7%, Russell +0.3%, Stoxx 600 +0.8%, Topix -0.1%, KOSPI -1.2%, Australia All Ord -1.1%, Hang Seng -2.9%, China CSI 300 -1%, MSCI China ETF -4.5%, Hang Seng Tech -5.4%, China Internet ETF KWEB (in StashAway’s portfolio) -9.6%, Cloud Software ETF SKYY/WCLD -1%/-0.3%, Gold -0.5% (Gold -6.1% YTD).

Many of the biggest global macro hedge funds were reported to be burnt in wrong-way bet on bond yields as yield curves got flatter not steeper, triggering billions in stunning losses in one of its wildest and most violent and vicious weeks for bonds in decades. Short-rates surge globally as central banks reset expectations, pushing gold price down. The thesis behind bets on steeper yield curves hinges on the Federal Reserve and other central banks not having to raise rates soon, something that should keep short- and long-dated bond yields relatively far apart. But hopes for that outcome are disappearing fast as the threat of persistent inflation starts to undermine easy central bank policies. In a span of a few days, the view that some major central banks will be slow to raise rates shattered into pieces. The flattening of yield curves quickened this week after the U.K. reduced bond-issuance plans and the Bank of Canada accelerated the timing of potential future rate increases. In Europe, investors sold off eurozone government bonds after fresh data showed that inflation in the eurozone accelerated in October at the fastest pace since July 2008; investors have pushed forward the expectations for rate hikes next year even after European Central Bank President Christine Lagarde said such a move is inconsistent with the bank’s guidance. Short-term yields from Canada to Australia jumped the most since the 1990s, catching even some of the best money managers flat footed, as policy makers shifted gears to move more firmly against inflation once seen as likely to be transitory. At the same time, long-term rates slid -- a signal that aggressive policy moves are likely to slow the pace of economic growth. Inflation is anathema to bondholders because it erodes the value of money earned on debt, weakening the asset class and triggering a broad repricing of bonds from safe government debt to risky corporate issuance. The Bloomberg Multiverse index, the largest gauge of the global bond market that tracks US$70 trillion in government and business debt, is on track for its poorest showing in decades.

U.S. stocks shrugged off woes at two of the biggest companies in the stock market, Apple and Amazon. Both companies warned investors Thursday afternoon that ongoing supply-chain disruptions were affecting their operations. Apple said the snarls were hindering the manufacturing of iPhones and other products and would bring increased difficulties during the holiday-shopping season. Amazon, meanwhile, posted lower-than-expected third-quarter sales and signaled that a tight labor market and supply-chain issues would weigh on fourth-quarter earnings. About 82% of S&P 500 companies that have reported so far this season have beaten expectations for earnings, according to FactSet data from early Friday afternoon, a pace never seen before the pandemic. For months, investors have been on high alert about such economic disruptions and have tried to determine the impact that stickier-than-expected inflation, labor shortages and shipping and logistics delays would have on global markets. Throughout earnings season, companies across many sectors have warned about supply-chain and labor constraints. But many are also betting customers will keep paying higher prices and stocks with pricing power are rewarded as ‘a war on margins’ looms. Excluding financial firms, companies in the S&P 500 that announced results have boosted net-profit margins by 40 basis points to 12.4% from the previous quarter. The data is the latest evidence of corporate resilience that has underpinned a rally in U.S. stocks. Interestingly, since 1927, the S&P 500 has notched gains in the final two months about 57% of the time. When the first 10 months saw the index rising more than 20%, as is the case in 2021, the odds of positive returns jumped to 75%. Inflows into equity funds also climbed to a seven-month high and the largest inflow this week since March, as a majority of bears were forced to convert to buyers. Global equities logged more than US$1 trillion in inflows during the last 51 weeks and the start of positive vaccine news. This is the biggest market structure dynamic of the year. For context, the prior best rolling 51 week record was US$250 Billion+.

Meanwhile, Asia’s corporate profits have fallen to more than a decade low relative to global peers, and further downgrades are on the horizon as China’s economic growth slows and global supply constraints remain. China and Hong Kong stocks slumped in week on earnings drag as China data to signal further contraction in manufacturing. Reports this week showed some of China’s biggest companies posted big losses or sharply lower earnings for the third quarter as China’s economic recovery faltered, including Ping An Insurance, oil producer PetroChina, carmaker BYD and the biggest developer by sales Vanke. China is amending its Anti-Monopoly Law for the first time since it came into force in 2008, beefing up antitrust penalties in an explicit push for more control over the digital sector, and increasing penalties and regulatory control. The new rules would also allow the SAMR to impose fines of up to 1 million yuan on individuals directly responsible for violating the law, including legal representatives, directors and other employees. This is a first for China. Investors rushed to offload Chinese tech stocks as a flare-up in Sino-U.S. tensions also sparked fears that more scrutiny from Washington could be in store for the sector. On Tuesday, the U.S. Federal Communications Commission voted to force China Telecom, one of three leading communications providers in China, to close its U.S. business. On the same day, Secretary of State Antony Blinken said that the exclusion of Taiwan, which China considers part of its territory, from the UN “undermines the important work” of the international body.  US-listed brokers Futu Holdings and Tiger Brokers fell sharply after a top Chinese central bank official warned online brokers who offer cross-border trades to mainland investors without a domestic licence are operating illegally. Shares of PAX Global Technology, a popular “value stock”, plunged 43.3% in Hong Kong on Wednesday before going into a trading halt after a FBI raid on a Florida warehouse belonging to the Chinese payment terminal maker, the third-largest provider of electronic payment terminals in the world, after Florida-based Verifone and France's Ingenico.

Market sentiment and excessive optimism over Cyclicals may be punctuated by warnings from scientists that Merck's "revolutionary" COVID drug molnupiravir - which purportedly cut hospitalizations in half during a study that was cut short - could cause cancer or birth defects, according to a report published Thursday by Barron's. Molnupiravir works by incorporating itself into the genetic material of the virus, and then causing a huge number of mutations as the virus replicates, effectively killing it. In some lab tests, the drug has also shown the ability to integrate into the genetic material of mammalian cells, causing mutations as those cells replicate. If that were to happen in the cells of a patient being treated with molnupiravir, it could theoretically lead to cancer or birth defects.

As euphoric traders piled into the trendy Cyclicals/Value Traps, we believe that there is a high probability of downside risk in chasing and catching them at exactly the wrong time after their sharp run-up from being blinded by the fiscal stimulus hopes and vaccine euphoria — the light at the end of the tunnel — and things can turn very nasty suddenly, as markets tend to underestimate how long that tunnel is, and how dangerous that tunnel is. This situation is very vulnerable for cyclicals to degenerate or revert back into its true ugly colors as cheap-gets-cheaper Value Traps once the vaccine euphoria fades or something negative happen on the mass vaccination roll-out or the vaccine does not prevent people from carrying and spreading the virus to others or new mutated virus strains erupt to render the vaccines ineffective. Once the vaccines actually start being administered at scale and the pandemic recedes, a lot of investors are going to wake up to the fact that the global economy is still dogged by a host of thorny problems that both predate and have been exacerbated by the virus. The current unsustainable market euphoria over Cyclicals, Value Traps, Zombies (companies who cannot cover their interest expense with cash from operations) and Vampires (junk-rated corporations with negative EBITDA) has created opportunities for long-term investors in the inexorable rise of a selected group of fundamentals-based structural growth innovators. These winners solve high-value real-world problems to generate visible and vigorous quality earnings growth before and during the pandemic, as well as are poised to enjoy continued healthy demand and staying power in a post-pandemic future when the world recovers painfully and slowly to transition from the Pandemic Health Crisis to the next crisis – the PTSD Post-Pandemic Growth Crisis. Our portfolio companies have shown resilience and scalability during this tumultuous environment and the management continue to make key strategy decision to expand their market leadership in their respective fields. The quiet HE.R.O. innovators have invested wisely in innovations that sharpen their exponential competitive edge for long-term value creation, strengthened their market position in the value chain that supercharged their cashflow dynamics, developed new channels, new markets and new customer base for revenue growth while improving their profitability at a time when most businesses are struggling, and nurtured their human capital and corporate culture to foster innovation and ESG sustainability. While the short-term day-to-day price movement can be volatile, what continues to be crystal clear is that the quiet structural growth H.E.R.O. innovators remain the most visible and vibrant pathway in a foggy, volatile, whipsawing, uncertain market to deliver sustained outperformance with their healthy fundamentals results.